Question

Use the Solow-Swan model to explain what would happen to steady state capital per
effective worker resulting from:
a. A decrease in the population growth rate.
b. An increase in labor productivity.
c. An increase in the investment share of GDP.

Answer 1

(A) In the Solow model, an decrease in the population growth rate decreases the growth rate of aggregate output but has no permanent effect on the growth rate of per capita output. A decrease in the population growth rate decreases the steady-state level of per capita output.

(B) Increase in Productivity doesnt impact the steady state capital per effective worker. Solow Model considers productivity improvements as an 'exogenous' variable – they are assumed to be independent of the amount of capital investment.

(C) An increase in the investment share of GDP: In the Solow growth model, if investment exceeds depreciation, the capital stock will increase and output will increase until the steady state is attained.